RBC: Here's the One Thing Could Derail the Bull Market

Don't worry—it's not happening yet

Job Fair

Wage growth is picking up.

Photographer: Daniel Acker/Bloomberg

It's been more than 1,300 days since the last market correction of more than 10 percent, yet Bloomberg reports today that U.S. stock strategists are sticking to their forecasts for the S&P 500 Index to rise 5.8 percent by yearend.

That's the most optimistic call since 2011 and that cheerfulness comes despite rather big headwinds like the situation around Greece and a looming interest rate hike by the Federal Reserve. 

So it's worth asking, just what -- if anything -- could derail the bull market?

In a research note published this morning, RBC Capital Markets analysts led by Chief U.S. Market Strategist Jonathan Golub, ask exactly what might cause the second-longest U.S. rally since 1950 to end. "Our work indicates that bull markets most often end when recessions ensue," the analysts note succinctly. You can see the dynamic in the below table, which shows various "recessionary indicators," plotted against several previous U.S. recessions.

Judged by those indicators, the U.S. seems to be doing just fine -- so far.

But there's one thing that could cause those indicators to flash red, according to RBC, and that's a change in U.S. wage inflation. As Golub puts it: 

... While the yield curve is generally the most important recessionary indicator, we believe the trend in wage inflation is paramount in the current environment. A sharp pickup in wages would likely cause the Fed to act more quickly, derailing the expansion. From an historical perspective, a 100 [basis point] move would be necessary to sound the alarm. While wages are clearly rising, such acceleration is absent.

So while pay has been picking up, it doesn't yet appear to be rising fast enough to worry the Fed, and force the central bank to raise rates, thereby derailing the expansion and causing lofty U.S. stock markets to come crashing down to earth.

Still, though, wage inflation bears watching. Not least because there is also a strong correlation between average hourly pay and the Fed's benchmark interest rates.

 

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